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Why advisers must map suitability to fund risk

Most advisers expect or demand that attitude-to-risk (ATR) profiling tools map directly to product providers’ and fund managers’ funds. Sadly some advisers do little more than match the client’s ATR score with a fund risk rating, in the mistaken belief that this makes their investment advice less subject to challenge.

Since it is hard to define a suitable independent and universal rating benchmark, many advisers simply take risk scores and associated mapping to funds on trust. But simply accepting the mapping of ATR scores to fund risk ratings without understanding them can be risky for advisers.

Why? Merely accepting and using a mapping tool will not get an adviser off the hook when a customer complains or the regulator undertakes a suitability file review and questions whether the risk of the investments actually matches the client’s profile. “I don’t know how it works” simply won’t wash in such circumstances.

It is the specific allocations of underlying assets and flexibility of the fund mandate where risks generally lie hidden. Asset allocations, even for those with identical risk ratings will vary, sometimes considerably, and can include levels of high-risk assets that are not immediately obvious. Fund managers may say that their process contains these risks, but if clients lose money in funds containing such investments, reliance on a risk mapping exercise will not enable the adviser to escape liability.

Understanding funds’ asset distribution by professional advisers should be a given. Yet scarily, there are many instances where advisers using a platform ATR score for fund selection are unaware of the asset allocation principles applied by the platform when rating funds. This situation should be deeply concerning and not only for clients because the adviser carries the liability. Ignorance of the asset allocation principles used in connection with advice will leave the adviser in a weak position with both regulator and FOS. Given such circumstances, the FCA’s findings published in its thematic review and its subsequent instigation of the file review earlier this year should be no surprise at all.

When demand for a mapping process for Harbour arose few years ago, the absence of a universally accepted, freely available and transparent risk rating process was a potential hurdle. We thought that a suitable benchmark, clearly understood by advisers and clients, would be a major benefit for all and the criteria that drove our rationale and approach included:

Avoidance of prohibitively expensive fees for financial data;

realism as we wanted a real-world benchmark that investors could actually buy rather than fictitious funds made up of a theoretic ‘basket’ of assets;

straightforward and transparent mapping method so that advisers could understand the process;

the basis for mapping Harbour particularly when used in concert with centralised investment propositions (CIPs) or an outsourced DFM service.

After input from trusted industry specialists, we elected to use Vanguard Asset Management’s LifeStrategy Funds as Harbour’s mapping benchmark. They are global, undertake extensive research and their funds are well respected. The result is that Harbour has a clear, independent and transparent benchmark for mapping that everyone can understand and this is a significant benefit to users.

The FCA’s thematic review into investor suitability suggests that there is much that firms need to do in order to raise their standards and their customer service and there are a number of steps that firms can take to reduce their exposure:

ensure that advisors understand clearly the underlying asset allocations as well as other attributes of the funds that affect investor suitability particularly for those investors with ATR rakings in the low and high score band quartiles;

avoid confusion between attitude-to-risk and investor suitability, they are completely different;

ensure that client suitability profiles rather than ATR scores drive the selection of particular funds or model portfolios;

where a selected fund’s risk score is different from the client ATR, ensure that the investment rationale is clearly documented and held within the client file to avoid censure in a subsequent file review;

Understanding the process of mapping risk profile scores to funds is fundamental to the provision of sound and professional financial advice. It is also the basis for good customer service as well as regulatory risk reduction and will, in the long term, increase the value of your advisory business.

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